Is Climate Change a Long-Term Alpha Generator? One CIO Believes So

The ESG investment industry is experiencing exponential growth as investors flood into the space, looking to either invest in alignment with personal values or to capture a piece of the market action. Although it is an unregulated space for now, standards could possibly be coming soon from the SEC, at least in regards to ESG reporting by companies, as more advisors and fund managers look to entice investors with various ESG approaches.

CalSTRS CIO Christopher Ailman recently said on CNBC’s “Delivering Alpha” that he believes climate change to be a “mega-trend that if you take advantage of it, and get ahead of it, it’s going to be an alpha generator for the next 30 or 40 years. If you don’t pay attention to it, it’s going to be a negative alpha and you’re going to be stuck with a low-beta return.”

Global assets put into ESG investing globally passed $2.24 trillion at the end of June, according to Morningstar data; the first time assets crossed the trillion dollar mark was in the second quarter of 2020, reflecting robust growth.

One of the biggest critiques of ESG right now is a lack of standardization across industries and within reporting. Wendy Cromwell, vice chair at Wellington, believes that all U.S.-listed companies should be required to disclose scope one, two, and three level emissions, and that investors and scientists need to be working together to evaluate what the actual physical risk for a company is from environmental and global warming impacts.

It’s not an easy thing for investors to do, digging through all the research and data. Carine Ihenacho, chief governance and compliance officer at Norges Bank Investment Management, explained that it’s important for investors and advisors to “find out what types of issues are material to companies…how does the company manage it, and how does the company then report the progress.”

While some funds go the route of divesting themselves of exposure to things such as fossil fuels to be an ESG fund, there are many proponents that believe in active engagement with companies and bringing about change through investing.

“Divesting doesn’t reduce the amount of carbon in the atmosphere. Engagement does. I can’t emphasize that enough,” Ailman said. “Engagement and turning peoples’ attitudes, turning companies around, is what’s absolutely critical now because climate changes isn’t just the energy industry, it’s a lot of other industries, and the whole world has to change.”

It’s been seen within the industry already with Engine No. 1, supported in part by CalSTRS, in removing and replacing three of the seats on the board of directors at Exxon.

“We took on that board. We changed that board and we are really changing that company from the top down,” Ailman said.

Putnam Engages Companies on Their Practices to Bring Change

Putnam believes in sustainability and holds ESG practices as a core aspect of its investment approach. Its ESG-focused active sustainability managers are a fundamental part of its work to align shareholder ESG values with investment practices by engaging directly with the companies invested in as to their ESG fundamentals and practices.

The Putnam Sustainable Leaders ETF (PLDR) invests in companies whose focus on ESG issues goes well beyond just basic compliance and for whom ESG is an integral part of their long-term success. These companies have transparent goals and provide consistent, measurable progress updates.

As a semi-transparent fund using the Fidelity model, PLDR does not disclose its current holdings on a daily basis. Instead, it publishes a tracking basket of previously disclosed holdings, liquid ETFs that mirror the portfolio’s investment strategy, and cash and cash equivalents. The tracking portfolio is designed to closely track the actual fund portfolio’s overall performance, and actual portfolio reports are released monthly.

Holdings as of the end of August included Microsoft Corp. at 8.28%, Apple at 7.38%, and Amazon.com at 5.01%. The fund was heavily allocated to information technology stocks (32.41%), followed by healthcare at 15.91% and consumer discretionary at 14.61%.

PLDR has an expense ratio of 0.59% and has 60 holdings as of the end of August.

Meanwhile, the Putnam Sustainable Future ETF (PFUT) invests in companies seeking to provide solutions to future sustainability challenges. It is a forward-looking approach as these companies are helping to develop ESG and solve problems related to sustainability.

PFUT focuses on impact companies as identified by its sustainability rating system and on investing in companies driving economic development, as Putnam believes that strong sustainability practices equate to strong financial growth.

PFUT’s top sector allocations as of end of August were 32.21% in healthcare stocks, 29.58% in information technology, and 8.70% to consumer discretionary.

The ETF has an expense ratio of 0.64% and has 69 holdings as of the end of August.

For more news, information, and strategy, visit the Big Ideas Channel.